Trading Rebates on Exchanges Should End, ICE’s Sprecher Says

Oct. 11 (Bloomberg) -- The pricing system used by the
majority of U.S. stock exchanges should be banned because it
encourages trading aimed only at collecting rebates, according
to Jeffrey Sprecher, chief executive officer and chairman of
IntercontinentalExchange Inc.

Regulators shouldn’t let venues offer maker-taker pricing,
in which an exchange charges some firms to trade and gives
others rebates, Sprecher said today at a Futures Industry
Association conference in Chicago. He said the pricing structure
discourages some traders from owning stock.

“Don’t allow us to pay for order flow,” Sprecher said of
the exchange industry. His Atlanta-based company runs futures
and energy markets. The pricing technique used in equities spurs
some traders to “simultaneously buy and sell on two different
exchanges” and get paid rebates on both, instead of making
money by holding shares, he said.

The number of U.S. stock and options exchanges has risen to
13 and nine, respectively, and one way they try to differentiate
themselves is with pricing plans. Maker-taker pricing is mainly
used to compensate market makers and other providers of bids and
offers, while traders who execute against those orders pay a
fee. Most futures exchanges charge trading fees and offer no
rebates.

Taker-Maker

The maker-taker system is reversed on some markets to pay
firms that trade against orders supplied by market makers or
others who are charged a fee. That pricing, called taker-maker,
in conjunction with the more popular structure may allow traders
to be paid to supply orders on one market and get rebates when
they trade against bids or offers elsewhere.

Cameron Smith, general counsel at Quantlab Financial LLC, a
Houston-based quantitative research and trading company, said in
an interview that there’s no need to eliminate maker-taker
pricing. The system was initially employed by Island ECN, a
trading platform that began competing with Nasdaq Stock Market
more than a decade ago. Smith was Island’s general counsel from
1999 to 2002.

“He’s saying some firms’ revenue is tied to the rebate,”
Smith said of the ICE executive’s comments. “In futures and in
Europe, there are plenty of markets that don’t have rebates and
yet these same firms are able to trade profitably.” The rebate
isn’t the reason most firms providing liquidity trade, he said.

Competition among market makers and providers of liquidity
reduce the difference between the highest bid price at which
people are willing to buy shares or contracts and the lowest
level at which they’ll sell, called the bid-ask spread, Smith
said. The rebate is among the factors considered by firms whose
computers decide what quotes to publish. If maker-taker pricing
ends, “the firms will just adjust to the new pricing structures
and that adjustment will result in wider spreads,” he said.

Wider Spreads

Wider spreads increase trading costs for institutional and
retail investors and may encourage orders to be sent to dark
pools or private venues that don’t display prices, Smith said.
Dark pools, many of which compete with exchanges and trade at
the midpoint between the best bid and offer, can save investors
more money when spreads are wider.

Sprecher said pricing structures like maker-taker may also
dissuade providers of liquidity from remaining in markets when
volatility increases. Some firms pared back or stopped supplying
orders during the May 6, 2010, plunge when $862 billion in
equity value was briefly erased in about 20 minutes during the
so-called flash crash, according to a report last year by the
Securities and Exchange Commission and the Commodity Futures
Trading Commission.

Cause, Effect

James Overdahl, vice president at NERA Economic Consulting
and a former chief economist at the SEC and CFTC, said the
report produced by the two regulators last year didn’t cite
maker-taker fees among the factors that contributed to the May
6, 2010, plunge. The agencies found that the cause had “more to
do with fragmented rules and a fragmented marketplace,” he said
in an interview.

“It was after the market was down and market data was
inaccurate that a handful of institutions withdrew from the
market,” Smith said. What Sprecher said “reverses cause and
effect.”

Following the plunge in May 2010, exchanges and regulators
have considered how to ensure that sufficient liquidity remains
in markets when volatility increases. Among options raised by
regulators in the U.S. and Europe are boosting obligations on
market makers and mandating that quotes remain in the market for
a specified amount of time.

Quote Responsibilities

U.S. regulators have increased some market-making quoting
responsibilities, clarified rules about when trades are canceled
to make them more uniform, and established curbs that pause
trading when prices rise or fall more than a certain amount.

Craig Donohue, chief executive officer at CME Group Inc.,
said at the futures conference that the securities markets need
to develop “bumpers and speed bumps to help to ensure market
integrity.” While regulatory scrutiny should also focus on
“abusive trading practices and behaviors,” adding obligations
on market makers isn’t necessary, he said.

“We’ve seen obligations in the past on specialists and
market makers,” Donohue said. “They generally don’t work.”
Futures markets, in contrast to securities markets that have
imposed trading obligations on market makers in the past, are
liquid and have no “affirmative obligations ever,” he said.